Inventory Planning »

In the last post we talked about turn-over and using an Open-to-Buy book. This time we will add gross margin to the mix.

Gross margin can be talked about as a percentage and as dollars. It is the gross margin dollars that we live on. Without gross margin dollars our business would not survive. So, obviously, gross margin is very important to a small business.

In a sense, gross margin dollars are easy to understand. It is the amount of money we keep in any sales transaction. So we pay $50 for an item, sell it for $90 and keep $40. Simple.

Making your buy is the starting place for creating a good gross margin. In the buying process, getting the best selling items, the best price, freight discounts, and payment discounts will lower price you pay and that especially important if there is a competitive price cap on the items.

Pricing the items is the next part of getting a good gross margin. You have to know what the item can actually sell for in your market place. Getting the highest price you can while remaining competitive is important. Pricing at the manufacturer’s suggested retail is a great place to start and may be critical to remaining a dealer. In today’s world the internet increases who you are in price competition with, so be aware.

With the price set you now know what the best possible gross margin amount is going to be. It is now up to you to sell the items at that price to keep the gross margin dollars up. The challenges to keep your margin are varied and require a keen eye to control. Theft reduces your margin by depriving you of the margin dollars you would have made as well as having to cover the cost of the item lost. Freight increases affect margin dollars by increasing the cost to get the product to you. Receiving mistakes, shop damage, overbuying are other issues that can affect your margin dollars. Of course, if you bought the wrong stuff and have to mark it down to sell it – then there goes the gross margin. Gross margin only becomes real when you have sold the items.

We have gone quite a ways in this discussion. Let’s look at a couple of definitions before we continue. You can talk about margin or about markup; both describe the amount of money that you make from the sale. Markup is often used to think about your pricing and gross margin is used to think about your gross profit dollars.

Calculate your gross margin percentage by dividing the cost of the item by the retail price multiplied by 100. Our example above of $90 retail has a gross margin percentage of 55%. $50 / $90 = .55 x 100 = 55%

Now, you’ve done all you can to get your pricing up and reducing the cost so that you have the best possible gross margin percent on the items. You now know what you will make on the sale when you sell the items at full price. This is where turn-over comes into play. Gross margin times Turn-over will give you a GMIT number. GMIT is Gross Margin percentage times Inventory Turn-over. If your turn-over is 3 times a year and your gross margin percentage is 50% then your GMIT is 150. You can use this to see the effect of turn-over on gross margin percent and use that to plan your inventory levels and pricing. Check out the OTB example here. You can see the GMIT row and how it changes.

You can play with the numbers to see what happens when your turn-over changes.

Turn-over 3.5 times. 3.5 x 50% = 175

Turn-over 4 times. 4 x 50% = 200

Here are some changes with gross margin

Gross Margin 55%. 3 x 55% = 165

Gross Margin 60%. 3 x 60% = 180

You can see that small changes in turn-over result in a larger GMIT than changes in gross margin. Increase your turn-over rate and keep the same gross margin will result in an increase in your gross margin dollars and you will be using less money on inventory because you are keeping less inventory in stock.

The OTB book can help you plan out your inventory needs according to your planned sales. Lay out your monthly sales then decide on your turn-over goal and you will have a start on how much inventory you will need to meet your sales and turn-over. For example, if you want 3 turns a year that means that you need to have 4 months worth of inventory on hand at the end of any given month. 12 / 3 = 4. Simply add up the sales goals for each of the next four months and you have the amount of inventory needed.  Now all you have to do is to sell that amount of merchandise each month, do your reorders to keep your stock level up and you have it.

Of course, reality will butt in and you will have to change plans to meet what’s real. That’s where the real challenge is.

Let me know how you do it.

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